SDCERS BOARD MEETINGS -October 16-17, 2008
Submitted by Patricia Karnes

Patti's Notes

(I attended the Business & Governance Committee, Investment Committee and the full Board meeting for these notes. There was no Audit Committee meeting.
Notes are by subject. They are my understanding of what happened.
Official CDs of SDCERS' committees and Board meetings are available through the Board Secretary; visual recordings are available through City Channel 24. Live streaming will be available soon. Full Board meetings are on Channel 24 around 5 or 6pm, usually the third Friday of the month, and usually repeat on Sundays at 1pm.)

CHANGE IN SDCERS' TRUSTEES
George A. Murray, a rock of strength and a mentor for SDCERS had his last day as Trustee. He had stayed on 19 months after his term, until Mayor Sanders filled his position. Shortly after he was appointed, George said, Mayor Murphy resigned and when Mayor Sanders was elected, he sent George, along with other Trustees, a Letter of Resignation to sign. Then George, along with six others, became the seven who refused to resign. They maintained their independent fiduciary duty to serve the members of SDCERS.
Then George saw the indictment of the Chief Administrator (Grissom) and legal person (Lorraine Chapin). ( See update in the San Diego Union Tribune Oct. 16, 2008, page B-1, "Charges added in pension fund case" and another article on Oct. 20, 2008, page B-1 "Experts eye gap between pension case indictments". Elaine Reagan, SDCERS General Counsel, will update the legal report next month on recent developments.)
There was bewilderment at the staff and Board level, George continued his story. George said a leader (Peter Preovolos) shaped the Trustees with one resolute obligation to members, and Peter told the Trustees to "Listen" to various fractions and speak up.
Serving on this Board has been a unique experience of mutual individual respect that George has never found on other Boards. He noted that the result is that even when the group conclusion is not your own conclusion, it is respected. Staff follows through and follows up, and this respect gives the staff a "cause", not just a job. George has the deepest respect for Board Members and he thanked Peter for finding Wescoe. George noted that Peter's communication goes into the community as well as inside SDCERS.
George said we could be assured there are other challenges ahead, and noted that Board President Tom Hebrank is of the school of Preovolos' management. (Former Board President Peter Preovolos is serving over his term until the Mayor replaces him.)
George is noted by the Board as going to the heart of issues and calling for votes when the discussion has no new points. Wescoe concluded his recognition of George "with love and affection."

TRUSTEES SWORN IN BY CITY CLERK:
Mayor Sander's appointees, Mark E. Oemcke and Raymond G. Ellis were sworn in to replace George Murray and also Peter Q. Davis, who resigned some time ago. No background or opening comments were given out regarding the new Board Trustees.
Once again there are the full 13 Trustees voting on the Board.

FINANCIAL REPORT

(NOTE: "Will there be life after Doug McCalla retires?" Doug McCalla, SDCERS' Chief Investment Officer will be bringing his Investment Team to meet and greet City retirees at the City of San Diego Retired Employees Association's 11:00am General Meeting on Tuesday, November 18th.  in the big meeting room at the center of the War Memorial Building, located at the north end of the Zoo's parking lot.
Want to order a hot $10 lunch and socialize? Call Sylvia at 858-272-0494, by November 12th, to make reservations for the last time we offer a lunch following the program. See you there, Patti)

Balances-
Sept. 4th unaudited assets were $4.622 billion.
On Oct. 2nd assets were $4.22 billion.
On Friday, October 17th, a day the market dropped 400 points and rose 800 points, to settle up 400 points, McCalla was responding "For what hour?" when he was asked what the fund was worth.

Executive Summary of Staff Reports, for September 2008, reported the September benefits payments and operating expenses were $13.9 million.
Doug McCalla noted the impact in the number of retirees, higher salaries at retirement, and higher DROP balances.

Income-
McCalla noted that income was down 20% so far this year. Realized gains (that add up to qualify us for the 13th Check and Corbett in November 2009) were $23.6 million for the July and August, the first two months of the fiscal year and the quarter ending in September looked good.

Market Status-
McCalla said the markets had retreated about 10 years and no investment banks were left in New York, only commercial banks. The situation was made worse on October 15-16, when hedge funds began dumping for cash. Expect a recession that is possibly worse than the 1980s. Strap in for the ride.

Re-Balancing-
Trustee Bill Sheffler asked how often SDCERS was re-balancing? On October 3rd, SDCERS sold some bonds for $177 million, bought some equity, kept some money for pension payments, the13th Check and Corbett, etc.
McCalla said they were re-assessing each day and he added that the market is diversified, unlike Washington Mutual, and SDCERS was moving into equity when opportunity is there.

SDCERS Board Quality-
Wescoe noted that many national board of directors, such as Lehman Brothers included trustees whose background could be as far ranging as working in film, in contrast to SDCERS' highly qualified Board members, who are actuaries, pension and financial experts, etc.

Risk Report and Action Plan:-
McCalla said SDCERS will be going back to evaluate this extraordinary test of risk structure. In the meantime, he pointed to SDCERS diversification of investments and segmentation of money managers, so there is control of the amount of investments in any one stock/bond/real estate, as well as, a blend of all of the controls. Money managers avoided the deepest mess that occurred. "This is a once in a lifetime experience", he concluded.
The plan is:
1) SDCERS will incorporate relative sector exposure.
2) State Street Bank, SDCERS' bank, will provide compliance monitoring. (State Street did not take on commercial paper and prevented SDCERS from having this trouble. They are mitigating risk to SDCERS by controlling transaction activity that goes on in the pool. McCalla noted a safety in the numbers in the pool.)
3) SDCERS will not wait for manager reports.
4) Worth the cost to do this.
5) Regular review of policy statement and tighten the policy as necessary.

Equity holdings:
SDCERS has 3000 companies. The Board requested a list of the top 25 by percent of holdings, and they were pleased by no more than $25 million in any one company. The list is available.

Market Neutral-
Market Neutral will be listed as a separate category and no longer appear under fixed income assets.

Real Estate-
Real Estate is the most illiquid in 70 years. Cash is king. SDCERS has 11% of the fund in real estate, 75% private and 25% public. Out of $513 million set aside for real estate, $489 million is now invested. SDCERS is under allocated in offices and that is good at this time.
Jami Hamrick reported that three companies were interviewed under a RFP: Callan Associates, Townsend Group, and Courtland.
Townsend was selected for their depth of services, national networking and success in working with the staff. Their contract is for a period of 3 years with options for renewal.

Private Equity-
SDCERS was pleased with the number of RFP responses and SDCERS' Cory Buuhoan, is focusing on having a boutique type advisor aboard by March 2009. Preparation, and research in legal work, etc continues, and as there is no rating service for private equity, network research is essential.

(Note: Retirees Violet and Ralph Brown attended the Investment Committee with me at the invitation of our Retiree Representative on the Board, Dave Hall.)

JUNE 30, 2008 ACTUARIAL EVALUATION
Look for this annual evaluation at the November Board Meeting. It includes the yearly funded ratio of the fund.

FISCAL YEAR 2008 AUDIT AND COMPREHENSIVE ANNUAL FINANCIAL REPORT
Investment data is being finalized. Macias Gini has received documents from SDCERS. Target release date is mid-December.

IRAN INVESTMENTS:
WOULD DIVESTMENT BE ECONOMIC OR SOCIAL, AND WHO SHOULD DECIDE?
Wescoe reported that the Port requested the Investment Committee to review SDCERS investments in Iran for possible divestment.

The Investment Committee heard that under AB221, which supports Federal prohibitions against investing in Iran, the State of California had prohibited the investment in Iran for CALPERS and CALSTRS. The committee did not forward the issue to the full SDCERS Board, agreeing with Elaine Reagan's opinion of October 3, 2008 that SDCERS outside fiduciaries invest by their judgment and the Board would be substituting themselves, and it was not advisable. There would be costs of trading to consider as well. She viewed the request to divest as a social objective, and viewed SDCERS financial experts as already aware of the risks.

On the other side, com mentors viewed Iran as a financial risk in the oil sector, energy sector and defense (nuclear) sector.
Risk #1 The USA fined a Dutch Bank $80 million for violating the prohibition. When Steve noted all money managers are limited by Federal laws, McCalla pointed out that these are not USA companies.
Risk #2 Only a matter of time before Iran uses nuclear weapons on Israel and the USA, leading to world economic trauma, etc.
Risk #3 Iran will nationalize SDCERS investments.
Risk #4 Terror free funds out perform terror funds. Some of the companies investing in Iran have 80% of their assets there. As other funds divest Iran investments, expect stocks to fall, until SDCERS would not be able to divest.

Elaine Reagan gave the Committee 3 choices: 1) No, 2) Research, 3)Yes.
On page 3 of Reagan's opinion was the door to action if the Board wished to take it:
"If the Board were to determine that current data supports the thesis that companies doing business in Iran face an increased risk of adverse performance, it would be appropriate for the Board to determine to divest from companies covered by resolution….Board should conduct an impact study before making this determination."
Dave Hall asked McCalla what was the timeline of impact studies? McCalla estimated 3 months as this had not been done before, and said he would need to consult a consultant for a cost/benefit analysis and return to the Board to approve the cost of the research. In any case, it would not be possible to determine actual future impacts on the investment. McCalla noted that on the Ball Park, hotels, and divesting from Sudan,  that SDCERS had relied on the money managers' evaluations. It would be a slippery slope for Board members to take on meritorious issues and direct investment risks themselves. Susan, Sheffler, and Steve preferred to share information with the money managers. Murray agreed and asked who is next, Korea, China, Thailand? Steve would add more countries as his son is serving in Iraq.

HOW TO SET DROP INTEREST ON ACTIVE DROP ACCOUNTS?
This new challenge to the Board covers crediting active DROP account balances and converting DROP account balances to annuities at retirement.

Why should you care about the active DROP interest crediting as a retiree?
Continuing to credit DROP interest at the same rate as SDCERS' assumed rate of return, could result in a lower funding ratio for everyone's pension funds and/or higher annual payments from the City or Port.

Options listed by Cheiron, SDCERS' actuary:
1) Change to 7.75%. The plan document says DROP is to be cost neutral. Cost is neutral if SDCERS earns 7.75%. Paying more interest to active DROP, than the Trust Funds earns in a bad economy year, costs SDCERS money and the City bears the increased risk of less than average returns. It also costs SDCERS money as the greater the rate interest on DROP, the more and earlier there are retirements, resulting in the higher the costs to SDCERS.
2) Fixed, but lower rate. Tie to 5 year T-Bill, currently 2.84%. or another investment. Lowers costs and risks to SDCERS. Reduces future annuity conversions.
3) Floating rate such as a recognized market index, like PBGC immediate annuity rate. Employee may decide against DROP due to the low interest rate. Franklin Lamberth noted it would be very difficult for employees to compare the outcome of doing DROP  without an actuary chart to help them.

Question: If you are active DROP, would lowering the active DROP rate result in a permanently lower rate if you elected an annuity for retirement?

Later, in comment, Joe Flynn brought up the idea that active DROP should have a choice on where they invest their funds.

As questions popped up: Does the annuity rate need to be the same at conversion? How to get to "actuarial equivalents"?  Elaine Reagan, SDCERS' General Counsel, asked they be saved for Closed Session.

Determination of the rate is further complicated by:
1) In September 2008, SDCERS' assumed rate of return was reset from 8% (since 1998), to 7.75%.
2) The Federal Government has discussed going to "market rate" on active DROP funds, but the Federal Technical Correction Act is dead , along with a solution for SDCERS interest crediting.
3) Can requirement of "actuarial equivalence" be met with a lower DROP crediting?
4) Board choices can not be arbitrary. Choices must have rationale.
5) Possible violation of the American Disabilities in Employment Act regarding employees over 40 years of age.

Fiduciary Counsel recommended any changes not be effective until January 1, 2009 "…to provide adequate notice of, and counseling to members…."

The Board will vote on active DROP interest crediting in November. Board Trustees with interests in active DROP were obligated to recluse or risk invalidating the Board's vote and forfeiting their own DROP monies. Steve noted "sufficient ambiguity", and Mark Sullivan, Steve Meyer and John Thomson left the room. Elaine Reagan, SDCERS' General Counsel, noted staff members in DROP or planning to go into DROP within a year were not allowed to work on this issue either.

This month, due to  litigation, the Board only listened to public comments and reports from SDCERS' actuary Cheiron, as well as, Ashley Dunning's fiduciary analysis from Manatt, Phelps and Phillips.

Wescoe noted Ashley's excellent presentation of the Board's fiduciary responsibilities when making decisions. Ashley said that the Board has "…the sole and exclusive power to provide for actuarial services in order to assure the competency of assets of the …retirement system." It must make active, analytical, informed decisions considering plan documents, applicable laws, Ordinances, and Board Rules.

Decisions "…must serve the overall best interest of members and beneficiaries." Members have "complex and cross-cutting" varied stakes. Factors in comparing the effect of decisions include hardship and the number of members affected. "Appropriate balance may not be obvious when interests within the member and beneficiary groups are not the same."

The Board's duty to members "…and beneficiaries shall take precedence over any other duty." The Plan Sponsor's costs are a lower priority.

The Board's legal questions were discussed in Closed Session. SDCERS's actuary, Cheiron, was not invited to Closed Session, so Cheiron would not be violating legal privacy, and can be an expert witness in litigation.

Jay Goldstone recommended re-setting the rate at 3.92%, based on a five year average of Treasury rates. He realized Fire and Police have a different arrangement. He asked the Board to act as prudent expert and assure the competency (definition of actuarial soundness) of assets.

Representatives from the Port and Airport asked for a continuance to next month in order to review and discuss this with their Boards. Bill Farrar, past President of the Police union, noted employees could get a T-bill rate on their own. Ron Saathoff, past President of Fire, noted that employees received DROP to keep them working in 1997, when the City placed a cap of 90% of pay on retirement benefits. Otherwise they would have left the City he noted. He argued for the assumption rate as planned for and paid for by the plan sponsors. A representative from MEA felt the rate was being lowered due to bad economic times. Joe Flynn said SDCERS has a captive audience that cannot take their money elsewhere. He said the City told employees they were in a safe harbor, and if there was a change in rate, the options should change.

NON-AGENDA COMMENT ON ROXANNE STORY PARKS
Patti announced the City of San Diego Retired Employees Association's Board had created an award and recognition program in 2002. This year the Board recognized Roxanne Story Parks, as having made a significant contribution to retirees by protecting the retirement system. As SDCERS' Chief Compliance Officer, Roxanne spent two years on the Voluntary Compliance Program and tax settlement with the IRS, achieving a Tax Determination Letter that keeps SDCERS tax free, and SDCERS' Chief Administrator, David Wescoe smiling. She completed the separation of SDCERS into three trusts: City of San Diego, Port and Airport. She also recently finished a graduate program in tax at USD's School of Law.
Roxanne has been asked to speak, to Chief Compliance Officers of Public Pension Plans, on the IRS Voluntary Compliance Program, at the Public Pension Financial Forum in Mobile Alabama from Oct. 19-22.

COMPLIANCE PLAN
An effective compliance program prevents and detects violations of the law by exercising due diligence to prevent and detect criminal conduct and promote ethical conduct and compliance with the law. Roxanne Story Parks previewed her seven key elements of a compliance plan for comment and review. She will be presenting the broad policy plan in November to the Board. Development of procedures will follow.

The Business and Governance Committee discussed policy and "…procedures to avoid hiring or promoting a person into a 'substantial authority' position who has engaged in illegal or unethical activities." Currently the City is doing full finger printing and full background check of employees they process for SDCERS, although 5 years ago the City failed to pass that information on to SDCERS. Sullivan inquired about Board members being checked as they joined the Board. Wescoe thought consultants should be checked also. JoAnne asked who would have access to this information? How would this affect the Mayor appointing new Trustees?
Regarding "…confidential and anonymous reporting of alleged violations…", Susan Gonick, Trustee, asked for definitions of "not in good faith", "frivolous", and "actual knowledge", at some point she noted that accusations become "snitch" and invasion of privacy. Kennedy asked for the total number of complaints per quarter and the criteria to determine if they were valid and the follow-ups. The committee liked Sullivan's suggestion to add "report in a timely manner."

FIDUCIARY INSURANCE FOR BOARD MEMBERS RENEWED
This $10 million insurance is in case the City does not follow the Muni Code and does not cover the Board members when they should legally cover them. The $319,918 cost is 5% less than last year.
At Board request, Wescoe reviewed materials on AIG's ability to pay off claims. Conclusion: AIG was selling off their other assets and they were rated as equal or higher than anyone that insurance broker, AON, does business with currently. SDCERS has option to cancel policy if AIG has problems.

CHIEF ADMINISTRATOR DISCRETION ON OVER/UNDER PAYMENTS
The Board increased the authority of the administrator from $5000 to $10,000 when resolving corrections. This will resolve 90% of adjustments found in the Year of the Data, without Board action.

TECHNOLOGY IMPROVEMENTS AND WEB ACCESS
David Bond reported that in the future, we will be able to access agenda items via video/audit by clicking agenda item numbers, using SIRE Technologies, the same program that the City Clerk selected. It will include SDCERS' licensing, installation and support for Board Agenda and Voting Management System. The Board waived the RFP process to piggy back on the City's sole source contract. SDCERS will also receive a discount that will continue in future years.

Bond reported that SDCERS has a new back-up and recovery system, replacing the 1990 system.
Progress is also happening in SDCERS financial accounting as well as ability to mine and analyze SDCERS data.

DISABILITY RE-EXAM AND 'ORDER TO RETURN TO WORK'
Regarding those that fail the re-exam process: The Board approved the letter, that it had requested Elaine Reagan draft last month, requesting the City Council and Mayor remove the requirement that  SDCERS "order to return to work" when a disability retiree fails the re-exam process. The Board currently cannot discontinue disability unless they order the return to work.

The Board recognizes it has no power that the person be re-hired. The City would continue to be notified that the person is no longer disabled, because the City cannot hire those who are on City disability pensions.

Elaine repeated that there is no case law put to test, by employees who lose disability benefits and go to court, when the City fails to return them to work.

Hall asked what happens to the person?
Steve voted "no", making the Board's vote 11-1.  (Preovolos had left for the airport with the Cheiron actuary.)

INDEPENDENT AUDIT COMMITTEE MEMBER RE-APPOINTED
Joe Flynn gave his recognition and appreciation to the three volunteer outside independent appointees of the Audit Committee and supported the re-appointment of Armon Kamesar to that committee. Armon served a start-up two years as the distinguished Chair. The Board approved his additional four year term, with Mr. Ellis abstaining as he knows Armon.

PRINTING CONTRACT
Board approved RFP to go out on printing.

SDCERS BUDGET UPDATE
The current budget was reduced by $407,727 to $41,369,095. The largest reduction was from removing 3%for raises that were estimated, but that never materialized, as the City did not approve raises for City employees. The greatest expense is the General Ledger System at the cost of $1 million.

SDCERS MEETINGS FOR NOVEMBER 2008
Full Board Friday, November 21 at 8:30am, 410 West A Street, 3rd floor.
Business & Governance Committee Thursday, November 20 at 8:30am.
Investment Committee Thursday, November 20 at 1:30pm.